UTStarcom Holdings Corp (UTSI) 2004 Q3 法說會逐字稿

Good morning, my name is Linda and I will be your conference facilitator. At this time, I would like to welcome everyone to the UTStarcom third quarter earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star and the number 1 on your telephone keypad. If you would like to withdraw your question, press star then the number 2 on your telephone keypad. Thank you. Mr. Sophie, you may begin your conference.

Thank you. Good afternoon, and thank you for joining UTStarcom's third quarter 2004 earnings conference call. I'm Mike Sophie, UTStarcom CFO, and I am pleased to host today's call with our CEO, Hong Lu. Hong will begin the call by giving an update on the progress we have made in executing on our vision of globalization. Then he will turn the call over to me for a detailed financial review of the third quarter and guidance for 2004, and 2005. Afterwards, we will open up the call for Q and A. Today's prepared comments are a little longer than usual as we have a lot of positive updates on our transformation to share, as well as some of the details on our confidence in 2005.

Before we continue, I would like to remind everyone that some of the information we'll discuss today constitutes forward-looking statements. Actual results could differ materially from our current expectations. To understand the risks that could cause results to differ, please refer to the risk factors identified in our latest annual report on Form 10-K, quarterly reports on form 10-Q, and the current reports on form 8-K, which are filed with the Securities and Exchange Commission. With that, I'll turn the call over to Hong.

Thank you, Mike. Good afternoon, and thank you for joining us today. UTStarcom continues to make a tremendous progress in our evolution from a Company's initial focus on a successful China and PAS market to the greater focus on becoming a global leaders in telecommunications technology. During this period of evolution, we will encounter volatilities associated with the maturation of the PAS market in China, and the lumpy nature of our growing international business. Despite the short term volatilities, we feel increasing confidence in our strategy and the long term growth prospects for UTStarcom.

On today's call, I would like to share with you those things that gives us the confidence in the long term growth strategy, and I will also address the challenges we face. I will start with an overview of the key highlights from the quarter, then, I will give update on improvement we continue to make. In the third quarter, UTStarcom generated 645 million in revenues, which represents a 10% increase year-over-year, net income was 5 million, with an earning per share of 4 cents. On a September 20th call, we gave some measurements of evaluating the process we have made in executing our globalization strategies. We are confident that over the next few quarters, you will see continued execution against these measurements as well as the significant ramp in international revenues resulting in strong profitable growth in 2005. Mike will give you more detail on the financial results and a guidance later in the call.

In the meantime, here are some key highlights from the third quarter: With a gain momentum in the globalization and a product diversification strategies this is a reflected in our booking and contract announcements. As of September 30th, we have a booked more than $600 million in contract outside of China for the year. This was the landmark quarter with numbers of substantial deals signing a new product areas for UTStarcom. These details form a foundation for the additional contract with these contracts as well as new contracts with other leading carriers in those and other geographics. In recap, some of these wins for the quarters.

Last week, we announced our first contract with Atomics(ph) to deploy our IP- DSLAM platform in Mexico. The initial contract value is approximately $50 million which we anticipated to recognize as the revenue in 2005. The contract also provides a significant opportunities in additional contracts for more DSLAM equipment as well as our other broadband products, including media gateways, and CPE. This was a highly competitive win for UTStarcom, in addition, this contract asks for the significant momentum we have established in a central and Latin America region, but the previously announced win in Brazil, Chile, Honduras, and Panama. We also announced several significant contracts in Japan for our next generation broadband products. We announced contract with the Japan Telecom for our IAN 8000 broadband access platforms and with the Softbank for the both NetRing multi services optical transport solutions and our first gigabit IPON win. The combined value of these contracts is approximately $370 million. Japan leads the world in broadbands innovation and services and it is a showcase for UTStarcom's product portfolio. We continue to capitalize on our success in Japan and are highly confident in our $500 million revenue target for 2005 in Japan.

We also signed our first contract with the China Mobile, the world's largest mobile operators to deploy 200 nodes of our NetRing solution in metropolitan Kimjing(ph) City near Beijing. UTStarcom now provides it's NetRing optical solutions to all of the major telecommunication operators in China. We were also awarded a contract with a China Telecom to deploy 130,000 lines of our IP-DSLAM equipment in 6 provinces. We are working very closely with both China Telecom and China Netcom to promote triple play application over the broadband and are currently in trial with the each of our M vision TV over IP solutions. In India, we announce 2 meaningful wins with the leading incumbent providers, DSML(ph) for IP-based DSLAM, and total control 1000 remote access platform for combined value of $17(?) million. These agreements represent initial step in the long term relationship between UTStarcom and DSML who was using UTStarcom's IP-DSLAM solution in a broadband access network across 198 cities in India.

In addition, we signed our first contract and receive initial purchase order of approximately $13 million for our IP-based MGN CDMA wireless infrastructure solutions with the Reliance in India. UTStarcom believes we are the only vendor in the world today who provides the complete end-to-end IP-based CDMA solutions. And we are now a key supplier to the Reliance to whom we are now selling both our wireless and our wireline products. As further proof of attraction of our new product lines, we've just signed our first commercial contract for our 3G TD CDMA platform with a UKBB, subsidiary of PCCW in the UK. We have received our first purchase order against the contract for approximately $10 million, this is also our first wireless win in Europe and will be a showcase for our wireless technology capabilities in western world. These CDMA wireless contracts in Europe and India, as far as negotiation that are underway with our carriers in US, are continued proof of our success of our globalization strategy and the significant technological and cost benefits of our (inaudible) based offerings. UT Starcom continues to lead in the world of innovation of both wireline and the wireless solutions.

In terms of the technology innovation, we made progress in both our wireless and broadband portfolio this quarter, including we launch our IAN 8000 multi service broadband platform which integrates functionalities of our DLC, voice-over IP media gateway, and IP-DSLAM and support TDM, IP enabled voice, and multimedia services. We also launch our mVision, our comprehensive end-to-end carrier TV over IP solutions, designed for telecommunication operators and broadband services providers to deliver a broadcasting quality TV on demand entertainment services programming over IP network. In addition, we launch our UT 22A PAS handsets, a world first PAS handsets with embedded personal identity module, PIM technology. Which enable our subscriber to transfer personal information to a new phone without any additional programming from the operator. This convenience will positively impact the past PAS handsets replacement market in China.

Finally, we successfully completed China's MII's 3G W CDMA field trial with a China Netcom in Beijing and feel very confident in our competitive position for the China's 3G markets. The key competitive technological advantage for the UTStarcom and foundation of our broadband and the wireless access solution is the mSwitch, our field proven IP core switching. Our mSwitch provides cost and the performance efficiency, as well as the scalability, and enable operators to offer enhanced revenue generating services such as voice, high speed data and television over IP. These are services that cannot be offering with a traditional ATM and TDM networks, and while other competitors are talking about IP, we are delivering it today. With more than 50 million lines of our next generation Softswitchs deployed throughout Asia, Africa, and Latin America, UTStarcom is the worldwide leader in IP core networking.

I'm very pleased with the growth of our global customer bases, and our continued technology innovation in a product diversification. However, we also continue to acknowledge the risks in our aggressive growth strategy and the challenges we face. As we discussed in our second quarter conference call, our primary challenge to scale our internal infrastructure and supply chain management to support our rapid global expansion. I'm very pleased with our progress, and I would like to update you on those now.

As mentioned, UTStarcom is working with Accenture to optimize our entire supply chain. In early Q3, Accenture begin their supply chain improvement project. Two examples of early profit includes the following: The first is in sourcing and procurement. We have initiated the strategic sourcing efforts that is focused on reducing our procurement expense and increasing the quality and the performance of our vendors. Through the pilot of this program, we have a reduced the spend for the commodity selected by 35%, which results in a projected annual savings so far of $3 million. We expect to continue this process with additional commodities with the goal of driving $25 million in savings over the next 12-15 months.

The second is improving the visibility in our internal ordering process. We have created processes that enhance our ability to proactively attract orders through our pipeline. This is expected to help us manage some of the lead time difficulties we faced in previous quarters. As a long term solution, we're moving additional supply chain processes to standardize ERP systems which we expect will greatly improve our operational efficiencies. In addition, we are redesigning selected supply chain planning, services management, and data management processes to increase customers responsiveness and further raise the performance of our supply chain. These improvements will help us to better support current growth, and satisfy our high customer demand.

The second challenges we face is integration of Audiovox handsets division, and successful introduction of UTStarcom handsets into the U.S. market. We now expect to close the acquisition in the first week of November, and are actively preparing the integration and new product introductions. We have submitted working model to our first 3 handsets for qualification to Verizon, Sprint, Dell Mobility and Virgin Mobile. In addition, we have received CDG phase 1 approval for our C2000 and C3000 models and have begun CDG phase 2 approvals for each. We have also received FCC's approval for our C2000 model and are working on qualification for our C3000 and 5000 models. We expect our first handsets to be shipped in the U.S. market in the first half of 2005.

Our third key challenge is to implement cost reduction program and gross margin improvement in the China market. As we discussed in our mid quarter conference call, China Telecom and China Netcom continue to see strong consumer demand for PAS. We believe the total PAS subscriber in China will reach 65 and 70 millions by the end of 2004, and up to 100 million by the end of 2005. We also believe that we will maintain approximately 60% market share for the infrastructure and 55% market share for handsets. As the smaller competitive handsets vendors are already loosing the market, in fact, now, 23 of the 32 PAS handsets supplier in China have less than 1% market share, including Lucent.

At the same time, operator are now primarily focus on expansion and optimizing contracts as the market for PAS maturity in China. This is the basis of our 1.5 billion revenue target for PAS in China in 2005. On the positive side, pricing pressure for the expansion contract is much less severe than for initial contract. Which translates into better gross margin, in addition, we are continually redesigned both the infrastructure and the handsets in order to lower costs.

Specifically for handsets, we have already introduced our internally designed power amplifier into our PAS handsets in the third quarter, and will introduce our RF-based ban Asyx in volume the first quarter of 2005. The combination of these two should take approximately $4 to $6, or 20% out of our costs of each of the handsets to improve our gross margin over the course of 2005. In addition, we continue to work with our suppliers to drive costs out of - - and have recently negotiated the significant reduction from Toshibas on their chip set. Also, new products introduction have better margin, for example, our UT 116 which was recently introduced have an ASP of $45 and a gross margin of 30%. Our UT616, which was also recently introduced and have already sold out is a clam shell color phone. The 616 has an ASP of $70 and gross margin of 28%.

In closing, there are continued to be some short terms volatilities in our resolves as we ramp our international revenue and continue our product diversifications. But, I believe we have the right product focus, business, and operating model to achieve our long term goal. I would like to reiterate a very important point I made on the second quarter conference call. I know that we are going through a temporary period of volatilities, however, I'm not running the company for the success for just 1 or 2 quarters. Instead, I'm focussed on delivering long term growth, profitability, and a dominant market position. I believe these factors are key to the shareholders value. I'm very confident that through our organic growth, strategic partnership, and selective and acquisitions we continue to expand our technology, products, addressable markets and global region to assure our long term success.

Now I would like to turn the call over to Mike.

First, let me provide some details on the third quarter results, then I'll discuss our updated guidance for Q4, and 2005. We closed the third quarter with 645 million, net income of 5 million, and earnings per share of 4 cents. These numbers were roughly in line with our recent expectations. Although our total sales for the quarter are nearly 10% higher than Q3 2003, they do represent a 6% sequential decline over Q2. Which is primarily reflection of the lower handset volume, downward pricing pressure in China, as well as timing of the revenue recognition on global contracts. Revenues from China, our largest regional segment, were approximately 91% of the company's total sales in Q3. As we progress into Q4 and 2005, the percentage of revenue from China is expected to be approximately 50% by early 2005. This is a result of the strong growth in global markets with the largest expected gains in North America, and Japan. Today, North America represents less than 5% and Japan represents approximately 5% of total sales, but are expected to reach 25 and 14% respectfully, by the end of 2005.

During the third quarter, wireless infrastructure continued to enjoy the fastest rate of growth, and accounted for more than 65% of sales as compared to 62% last quarter, and 35% in Q3 2003. Conversely, handset revenues declined as a percentage of sales to approximately 25% this quarter, from 28% last quarter, and 50% in Q3 2003. We continue to experience declining gross margins which came in at 21.3% in the third quarter. This compares to 25.6% last quarter, and 31.8% in Q3 2003. The primary reason for the gross margin decline was the continued weakness in our handset margins in China due to pricing pressures and overall softness in the China Telecom market. Handset margins came in at 14% for Q3, versus 19% in Q2.

Gross margins were also affected to a lesser extent by increased costs associated with the initial ramp-up of our new broadband products. These new products brought wireline margins below 15% for the quarter, but will quickly go back above 40% as we ramp volumes in the coming quarters. Total operating expenses for the third quarter of 135 million were 8% higher than in the second quarter and increased to 21% of sales. Although we've been successful in recent quarters at holding our operating expenses generally in line as percentage of sales, this quarter we experienced a couple of unusual items. First, our sales and marketing costs increased because we booked additional reserves for bad debt this quarter due to the slower collection rate on our receivables. This quarter our DSO level increased to 103. Although we have historically experienced a very low rate of actual bad debt losses, we are booking reserves consistent with our bad debt policies, I'll discuss our DSO's further in a minute. We also have experienced a higher R&D run rate this quarter associated with our investment of additional professional staff, as well as outside professional services. We continue to remain focused on driving long term value through investments in innovation and development, and the key areas of R & D focus in the third quarter included wireless CDMA 2000, W CDMA, TV CDMA, and on the broadband front, our gigIPON, MSTP, IN 8000, and in our handsets, the initial CDMA models for North America. This quarter, we experienced a change to our estimated effective tax rate from 20% to 18% due to the revised estimate of the current year taxable income and proportional shift of profits into China from higher tax rates jurisdictions.

Now let me transition discussion of this quarters cash flow and balance sheet. As expected, we are pleased to have achieved 98.9 million of positive operating cash flow in the third quarter. This was accomplished primarily through the continued improvement in inventory management as well as substantial cash payments for our large Japanese contracts. Our cash in short term investments balances as of September 30th, was approximately 796 million, as compared to 562 million at June 30th. We continue to see an extension of the cash receipt cycle and as of the end of September our accounts receivable balance increased to 691 million. This represents an increase in day sales outstanding from approximately 71 days during the second quarter, to 103 days during the third quarter. We projected the DSO's would increase on the last earnings call, but they have increased by more than we anticipated. The majority of the DSO extension is a result of the continued slow down of payments by our customers our China, especially China Netcom as they prepare for their IPO. We are also experiencing very aggressive payment terms from various competitors in China. DSOs should move back into the 90's in the fourth quarter.

Even though DSO's have increased I would like to remind everyone of the excellent history of collections we have had with our customers in China, and want to emphasize that this is strictly an extended payment cycle and not a reflection of China Telecom or China Netcom's inability to pay. Timing delays on global revenue recognition also contributed to the higher DSO's in Q3. We are very pleased with our improvements to inventory management, resulting in an increase in inventory turns to 2.9. This is a contrast to inventory turns a year ago of approximately 1. As of the end of September, our total inventory and deferred cost balance was 608 million.

As discussed on the September 20th call, customer advances are up significantly, primarily driven by the recent (indiscernible) contract with Japan Telecom. On September 30th, customer advances were 280 million, which represents an increase of 131 million compared to June 30th. We had short term borrowings of 177 million in the quarter, these represent draws on our lines of credit in China. This allows us to fund short term working capital requirements in China without having to transfer cash from the U.S.. It also allows us to continue to maintain significant cash balances in the U.S. for international expansion needs. With respect to guidance, as Hong said earlier in the call, UTStarcom is in the process of a significant transformation. We recognize and want to be open with the investment community that there will be volatility from quarter to quarter in the short term as we ramp new products and technologies and expand our global presence, while also facing the maturation of the market in China. This volatility should subside as we significantly ramp revenues from new geographic and product areas.

Over the last few quarters, contract bookings in the new areas have far exceeded recognizes revenues. With time, this gap will narrow, leading to higher visibility, and eliminating current lumpiness in global revenues. We expect this to happen in the second or third quarter of 2005 when we recognize revenues from a number of recently announced contracts including the 290 million dollar order from Japan Telecom. We are doing our best to provide accurate guidance as we go through this transition, but do realize that the current volatility and lumpiness in the revenue recognition make it difficult to guide to precise revenue distribution from quarter to quarter. However, we do feel that we have good visibility, and strong confidence in the full year of 2005 results. Since the September 20th conference call we continue to sign contracts but do see some shifting dynamics with impact on our fourth quarter guidance. Some of these fourth quarter changes include a shift of 28 million in anticipated revenue associated with our mVision, TV over IP product from the fourth quarter of this year into 2005. We have signed a contract , and we will ship the product on the four quarter, however, we anticipate that receipt of final acceptance for this brand new product will shift into 2005. This is somewhat offset by an additional 16 million of gigIPON revenues that we now expect to recognize in Q4. The net impact of these timing of these contracts on the Q4 gross margins is approximately 5 million.

Secondly, we are also looking at a $7 million increase in SG&A expenses in the fourth quarter. This increase is primarily driven by staffing and facility increasing in Japan to support sales now anticipated to be greater that 500 million in 2005, and also, as we mentioned earlier in the call, we are accruing higher allowances for doubtful account reserves per our policy as a reflection of the longer customer payment cycles. For the four quarter of 2004, we estimate revenues will be approximately 875 to 885 million, including approximately 140 million international revenues from our core operations, and over 250 million from ACC.

Let me pause for a second and make a very important point. We are actually shipping over $400 million worth of product to international customers in Q4, but anticipate recognizing only 140 million in international revenues. Let me continue with the guidance, by product type, wireline systems should represent approximately 15% of sales for the quarter, and 10% for the year, and handsets will account for approximately 55% of revenues for the quarter, and 40% for the year, total revenue from wireless systems will be approximately 30% for the fourth quarter and 50% for full year 2004. In Q4, core company gross margins should improve slightly, and come in at approximately 22%. ACC gross margins should be approximately 4.5%, bringing our overall gross margins to 17% for the fourth quarter. SG&A in Q4 should increase in dollars and come in as a percentage of sales at roughly 10%, inclusive of Audiovox . R&D in Q4 should also increase in absolute dollars and in come in as percentage of sales at approximately 6-7%, inclusive of Audiovox.

Intangible ammortizations should be approximately 5 to $6 million in Q4, other income and expense should be income of 4 million in the four quarter, this figure reflects interest income, expense, tax refunds, potential foreign exchange and impairment charges. Joint venture equity and incumbent loss should be a loss of approximately 1.5 million and our effective tax rate for 2004 should be approximately 18% plus or minus a couple percentage points. The GAAP(ph) earnings per share guidance for Q4 is break even, giving the volatility associated with new products and customers this could swing to a slight loss or a slight profit. And cash flow from operations should be slightly positive for both Q4, and full year 2004. Since our mid quarter update call, we've had more time to analyze our backlog, as well as revenue opportunity from the contracts currently in discussion. This has given us more visibility into next year, and we continue to remain confident with a revenue guidance of 4 billion. We - - with respect to our revenue guidance of 4 billion, let me share with you our internal plan that breaks down UTStarcom's 2005 revenue projections by geography and by product. Revenues by geography: China should represent 2 to 2.2 billion in revenue; North America, .9 to 1 billion inclusive of Audiovox; Japan, 500 to 600 million; India and other Asia, 100 to 200 million; Latin America, 100 to 200 million; Europe and Africa, 100 to 200 million. Breaking these revenues down by product types, PAS hand sets and infrastructure, 1.5 to 1.6 billion; CDMA handsets, 900 million to a billion; broadband, which included our IP-DSLAMs, MSTP, DDPon(ph) and CPE 1.2 to 1.3 billion; and non-PAS wireless which would be probably like TDCMA and CDMA, approximately 300 million.

Now I would like to give you a sense of what gives us the confidence in those numbers. Our year to date bookings are very strong and we have significant backlog in place. Two, in China, the PAS subscribers will go from 65 to 70 million at the end of 2004 to approximately 100 million in 2005, which drives revenues from both handsets and infrastructure. We continue to have 60% in the PAS infrastructure market and 55% share in the PAS handset market. Also in China, our MSTP, IP-DSLAM, and next gener - - NGN equipment all continued to gain momentum. Three, in Japan, we have announced nearly 400 million in contracts over the past few weeks. Four, in Latin America, we just announced that 50 million-dollar contract with Telmex; are in continued negotiations for both wireline and wireless products in the regions. Five, in U.S. Audiovox is currently running at a run rate of over a billion in revenues, so we have only factored approximately 900 million into our guidance. And six, in our global wireless infrastructure markets, we continue to sign both CDMA and TD CMA contracts with key carriers around the world, including Reliance in India, and PCCW in the UK. Other key contributor to our confidence in 2005 is gross margin improvement.

As Hong discussed early in the call, this is a major area of focus for UTStarcom. We see improvements from 3 major areas. 1: international revenues. International revenues not including Audiovox typically carry gross margins above 40% therefore, if international revenues ramp throughout the year, they will contribute a higher percentage of the mix and overall gross margins will improve. 2: PAS in China. As Hong mentioned, contracts we are currently signing for PAS infrastructure in China are primarily expansion contracts which do not have the same pricing pressures as initial contracts. At the same time, we continue to drive costs out of the product, and as such, the contracts we are now signing have margins in the low to mid 30's. In addition, as Hong discussed, the introduction of our Asyx(ph) in volume of 2005 will drive significant cost savings next year.

And 3: Audiovox. We expect to drive improvements in the Audiovox gross margins by introducing our own design and manufactured handsets into the channel throughout 2005. The specific guidance for 2005 is as follows: Full year, 2005, gross margin guidance inclusive Audiovox is approximately 25%. For modeling purposes it is important to note that international revenues will ramp throughout the year, along with a phase in of our internally designed CDMA handsets and PAS (inaudible). This should also be reflected in gross margin improvements throughout 2005 to end at 25% for the full year. SG&A expenses should be approximately 10% of sales for the full year, and R & D expenses should be approximately 6-7% of sales for full 2005. Other income and expense, in equity income and loss should be a gain of 6 million for the year. This figure reflects interest income, expenses, tax refunds, and potential foreign exchange and impairment charges. And joint venture equity income loss should be a loss of approximately 4 million for the year. Our effective tax rate for 2005 should approximate 23%, and our GAAP EPS guidance for 2005 is approximately $2. In 2005, we expect to be cash flow positive from operations and also free cash flow positive. We'll provide more specific targets for cash flows on future calls. Amortization of intangibles is expected to be 25 to 30 million for 2005, and our CapEx should be approximately $100 million in 2005. Share counts should be between 130, and 135 million shares for the year. Given the short term volatility we are experiencing, we prefer not to give specific guidance for Q1 2005 at this time, but would like to point to general Q1 trends which typically include a slow down in the U.S. handset business after the Christmas holiday, and specifically include a slow down in China related to the Chinese New Year. This combination of these factors typically leads to a decline in first quarter revenues versus the prior quarter. At the same time, we continue to sign contracts globally, building backlog internationally. All of the above leads to an increased confidence in our total 2005 guidance.

Finally, on the September 20th call, we laid out some metrics you can use to monitor our progress going forward. Let me recap some of the progress we made in Q3 against those metrics. The first key metric we gave was booking announcements. In the third quarter, we announced nearly $400 million in contracts. These bookings are indicative of the tremendous amount of demand where seeing globally, and contribute to our visibility for 2005. The second key metric was contract wins with tier 1 carriers worldwide. During the quarter, we signed contracts with new customers Telmex, Japan Telecom, China Mobile, and PCCW. In addition, we signed contracts with existing customers including Reliance, (inaudible) and China Telecom and China Netcom. The third key metric was continued subscriber demand in China. PAS subscriber numbers in China now have reached 60 million, an additional 25 million subs in the first 9 months of 2004. We continue to expect PAS subs will reach 65 to 70 million by the end of 2004, and approach 100 million by the end of 2005. The fourth key metric is market share. We continue to be a leader and gain share globally with our IP-based DSLAMs, softswitching, and now optical solutions. For example the gigIPON (ph) contract that we recently announced in Japan will represent the largest PON deployment in the world. In addition, the DSLAM wins with Telmex in Mexico and Reliance and DSNL(ph) in India, clearly show we are taking share from the incumbent leader Alcatel. Finally, in the PAS handset market, we continue to hold 55% market share despite fierce competition and believe we have the opportunity to gain more share with the introduction of several new innovative models in 2005.

A key metric we would like you to track is the introduction of new products. During the quarter, we launched 3 key broadband products, our gigIPON solution, fiber to the home, our IN8000 multi-service access broadband solution, and inVision, the most comprehensive end to end video over IP service platform in the market today. We believe these products are revolutionary in the market and will be key pieces of our total broadband solution. Before I turn the call over to the operator for Q&A, I would like to take time to discuss a recent common question we've fielded from the investment community. Sarbanes-Oxley 404 compliance and internal controls. The Company is absolutely committed to this process, and is spending significant amount of resources and time on the issue. Hong and I personally participate in several meetings each week to provide management support and ensure all issues are being addressed in a timely manner.

Some of the areas we are investing in to improve our internal controls continuing company wide implementation of Oracle ERP and MRP systems, and working with the Accenture on supply chain improvements. In addition, in the third quarter, we hired a Chief Accounting Officer and a Chief Quality Officer. While we are working diligently towards 404 compliance, we can not guarantee that the Company will be able to meet the December 31st deadline. This is a timing issue, as they auditors need to be able to test all processes over reasonable period of time before they can attest to our compliance. Some of the challenges we face are due to the tremendous amount of growth and expansion we have had in such a short period of time, as well as the recent implementation of new business systems and continuing improvements for the process to support our growth and improve controls. However, we take the issues of compliance very seriously and are committed to meeting our compliance obligations. We will continue our efforts and progress not only this year, but on an ongoing basis into 2005.

I would like to close the discussion by reiterating Hong's confidence in our long term growth plans. UTStarcom is going through a dynamic transformation, we believe we have all the right pieces in place to build on our success as one of leading global telecommunication suppliers, but that success does come with challenges. I hope we've been able to lay out for you how we expect to take on those challenges, and why we believe UTStarcom will achieve it's long term goals. Now we'd like to open up the call to the Operator for Q&A. Linda?

At this time, I would like to remind everyone, if you would like to ask a question, press star and the number 1 on your telephone key pad. First question is from Bill Choi of Kaufman Brothers.

Thank you. Mike, if you could kind of run through gross margins here, it looks like versus last earnings call you've had revenues that were essentially 50 million higher than your previous range. I think most of that occurred (inaudible), wireline was stronger than you had, you know, made it sound like here. So just talk about maybe gross margins by those 3 components, infrastructure, handsets, and wirelines, and what the surprise was in gross margin.

Well, the reference point I'd like to give you is the September 20th call, we had guided to gross margins, and we expected them to be about 22% for the quarter, so we are slightly below that 22%. Some of the changes from the September 20th call, is we realized a little bit more revenue in China than we had anticipated, a little bit less in international. If we take a look at our margins by product area, as I mentioned, the wireline margins came in a little bit below 15% percent which was all attributed to, you know, start up and ramp up costs on the broadband products. And those will quickly jump back in excess of 40%. The other areas, the handsets, those came in at 14% versus 19% in Q2, so I think clearly the handsets are under pressure. Now we talked about the things we are doing with not only the Asyx, the supplier, negotiations and also the introduction of some brand new models that are doing quite well, so we sees those margins coming up as we move into 2005. And on the wireless infrastructure, those margins ran in the mid 20's, and those are moving back up into the 30's as we sign new contracts.

Okay. And can you also determine that the wireline sales looks like the decline wasn't as bad as your discussion back in September. It was only down by 5%; is that correct?

Yeah, again, as I mentioned, we feel extreme - - you know, some of the uncertainty is when are you going to achieve the final acceptance on some of these, is there a service element that could delay revenue recognition? And as I mentioned, we are shipping over $400 million of international product in the fourth quarter, and so just (inaudible) question if the final acceptance and service elements are going to drive when we actually recognize revenues, but the business is building very nicely.

And also, can you give the amount you are spending for Sarbanes-Oxley in Q2. I think the number for June was (inaudible) incremental $70(?) million for - -to come into compliance including using (technical difficulties) Do you have a comparable number (technical difficulties) and what do you think the full amount would be for all of '04?

Yeah, I don't have an exact number to throw out at you. I can tell you that, you know, we're spending across the board, you know, complete Oracle implementation on a global basis; as you know, we've hired Accenture to work on our supply chains; we are working with Deloitte as advisors on 404; and then it's not a hiring internally of resources to help on the process. So we're making great progress, it's certainly a lot of money, but I think we feel the benefits that we're going to gain from 404 are going to deliver a lot of profitability in the future. Thanks.

The next question is from Tim Long of Banc of America.

Tim?

Hold one moment, please. Your line is open.

Mike, if you could just talk about your margin guidance for next year, has the outlook for Audiovox closed margins changed and what risks do you see that since it sounds like the products are going to start shopping in the middle of next year? What gives you the confidence that you'll be able to expand those gross margins and just a little more on the timing there. And then Hong or Mike, if you could just talk a little bit about some of the new management, some color on background for the Chief Accounting Officer and Quality Officer, and also what are some new responsibilities that will be bestowed upon those people? Thank you.

I'll take the margin question, Tim. With regards to Audiovox, and all of our margin,, we are assuming about a 25% margin total Company wide for next year. I think, as you know, the current core business for Audiovox is running gross margins at about 4.5%. We are not assuming any improvement there so we want to be extremely conservative in our modeling. Not what we are assuming in improvements is where we design and build our own CDMA handset and we run those through the channel, we believe we can achieve margins on that piece of the revenue of about 20% plus. And as we talked about through the call process, you know, we are moving forward with 3 models, and we feel very encouraged about bringing those into the channel next year.

When you take a look at the, you know, the other pieces of business, the handset business in China, you know, we do see those margins coming back up from, as I mentioned 14% here in Q3. You know, high teens or low 20's next year. We look at the infrastructure margins moving back into the 30's, as we are signing the contracts, now for those, and on our international non-Audiovox revenues, those margins will be surplus of 40%. So on a blended basis, we put all that together and we feel very good about the 25% for next year.

Regarding our two new additions, one is our Chief Accounting Officer and the other is Chief Quality Officers, and we have viewed that very important addition to us, and Sheldon is our Chief Accounting Officer who has an accounting background from Deloitte Touche, and then he went to work for the private sector and come back to work for us. And this is very, very important addition. And we have already given him tremendous number of work load, and that's something we have felt working in the future giving us much stronger, the financial backup for our future moving forward in the future. Now, with another Chief Quality Officers has been in the industry for more than 20 years, he speaks many different languages, including Chinese, and - - and English, and of course, and Malay (ph), and he has been working for the industry's in Canadas' and for the government part of the sectors, as well as coming into the recently with the wireless sectors as well. And we have been asking him to not only looking at the quality in our R&D's, but also in manufacturing and overall quality as a whole that we have asked him to taking a big part of the responsibilities, and as we speak, he's in China now, and I've been hearing a lot of positive feedback that he's working very, very closely with our team and he's already jumped into the work.

Next question is from Mike Ounjian with Credit Suisse Boston.

Great, thank you. In, you know, Mike looking next year at the international margin guidance of 40% plus, excluding Audiovox, I just wanted to get a sense of how much variability there is between different products and different geographies, and between India and Japan, or some of the wireless or wireline products.

I want to be careful here, because customers could be listening to our trunk, to the call, or get replays of it, but there can be variability. I would tell you typically, you know, a non-China international margin it could be something in the mid to high 30's on the low end, and it could go as high as 60% plus. Is something that we were able to achieve. Now, I think I would want to point out that we had mentioned on the contract for $290 million, that those margins were above 40%. So you know, again, we have got a substantial backlog and we have a lot of confidence on that blended basis coming in in excess of 40%.

Great. And just, on the housekeeping side, and I apologize if you mentioned this on the call, did you give what the operating cash flow number was and the CapEx number for the quarter?

Yeah, but I'll repeat. The operating cash flow was about $99 million positive for the quarter. I did not give the CapEx number, but our CapEx I believe was $37 million for the quarter, outlay. That included (inaudible) our building was 21 million of expenditures for the quarter, and for any of you that are coming to visit us in China, you know, we now have the Hong-Shoa building open and you guys can see our brand new building. It's quite a showcase.

Thanks, Mike.

Next question is from Hasan Imam of Thomas Weisel Partners.

Hi. This is (inaudible) on behalf of Hasan.

First I have actually one clarification issue regarding your 3G trials with China Netcom. Can you comment a bit more on that? As far as technology and when you think China will be ready for --

Sure. Okay, now. We are working with the China Netcom is our operator, and in Beijing, and there's only 2 companies that was selected in Beijing. One is ourself and another one is Nokia. And we do have to do that in typical ability test between 2 of us, and on top of that, we have to make sure that our call, has to be able to make it to Motorola and (indiscernible), and various other companies. And they have been - - just, this particular field trial has been real close to the commercialized trial, 1 step before the trial, what I would probably call the last stage of our Beta tests. And we have been have a large number of phone calls was made and so the results we have, we have been very pleased to say that we have been passing in a very high score through this MI test.

(Inaudible) This was like TCDMA?

This is a W-CDMA.

Oh a W-CDMA, okay. Thank you for clarifying that. And I have one follow up question. One additional question. Given your redesigning or getting into the CDMA handset business, do you foresee getting into the (inaudible) handset (inaudible).

Those are something we are very interested to look into. At this moment, we do not have immediate plan to do EVDO handsets now, and we will be looking more closely in our next year. At this moment, we are still 1x and we are also looking to the W-CDMA as well.

Thank you.

Next question is from Jason Chai(ph) of ThinkEquity Partners.

Hi, a few questions here. Mike, can you talk about the gross margins on your wireline infrastructure stuff? Did you say that was 15% this quarter?

Yeah, I said it came in slightly under 15. Again, it's just s very, initial charges and ramp-up costs it's gonna bounce right back to 40%.

In the December quarter?

Yeah, I would expect it to move up to 40% in the December quarter.

Okay. Got you.

Or at least, or let me qualify that. It will be in the 30's as a minimum, and definitely 40's by Q1.

Okay. And then, as far as timing on the PAS Asyx, when you do you expect to see a positive impact on gross margins off the the new Asyx?

As of right now, we are in final stage to have our sample being built. And so hopefully, sometime that we will have a working sample of before the end of this year, or beginning of the next year. And we are now aggressively implementing it, so we will have our first units coming out in either later part of Q1 or beginning of the Q2 to have this commercially introduced in the market. After we have introduced that, we have seen successful launch, we will be gradually to increase the number of our handsets, so the bigger impact, I will probably say, not until the latter part of the next year.

Okay. And this is, the new Asyx goes into new handsets only, right?

That's right.

Okay. And then last question here. Can you talk about PAS handset ASP's this quarter?

Yeah, I've actually got that number. Let me just - - before I give you those ASP numbers, let me just point out though, that those the Asyx's are not the only thing we are doing to improve the margins on handsets. And I just want to remind everybody that Hong's comments about the new models that have been introduced as well as the supplier negotiations.

Okay.

Now on the handset ASP's, I want to be sure, and maybe you don't have the history, in 2003 the (indiscernible) ASP's ran about $70, and I'll just give you a trend here for 2004. Q1 came in about $58, Q2 around 55, and Q3 around 52.

52? Okay.

And again, there's also the features, you know, the features aren't always apples to apples, depending on what the customers want, but that is the trend.

Thanks.

Next question is from Steven McSurly (ph) of Prudential Equity Group.

Hey, Mike. It looks like for the gross margin, to take another stab at this here, you are looking for an 800 basis point gain from the fourth quarter to the year average for '05. How much of the upside is going to come once we factor out the seasonality for the December quarter here?

Are you talking about 2005 improvement?

Yeah. You know, you are looking at 17%. I would imagine with the seasonal uptake on the handset side, that's going to weigh on things for December. I'm just trying to get a feeling for once we move that out, how much strength you pick up beyond there.

I think we are looking at the core business, before Audiovox, just to give you a very rough number of moving to about 30% next year, if that helps. And again, I think, you know, again the way I would break it down, as I did earlier on the Q&A here, was that the PAS handsets move from their current 14% back up, you know, around 20 or low 20's. Again, the infrastructure, we're already starting to see the contract signings, so it's just a question of bleeding off the backlog and having the new contracts starting to come into revenue will be in the 30's. And then on the, as I talked about the infrastructure in outside of China being north of 40, so again, that's going to ramp up very quickly as we move into next year.

Steve, there probably, this is Hong, the major composition, the differences for the China revenue versus international revenue, we will have a very high percentage of, non-China revenue coming out, so that will contribute higher margin as well.

Thanks, guys.

Sure.

Next question is from Tienyu Sieh of Merrill Lynch.

Hi, Mike. I was just wondering if you could just recap the tax credit for this quarter and how it turns out for the fourth quarter?

Yeah, it's good to talk with you again. The tax rate, is (inaudible) year to date basis. And what happened during this quarter is we revised our estimate of profitability for the year, and given the timing of international contracts, so as we've talked about on the September 20th call, and we're trying to reiterate today, we are shipping a lot of product, but strictly the timing of the revenue recognition on those is tied to final acceptance and in place of the service element. So we've reestimated what our level of profitability would be for the year, as well as how much profits would come in China versus other tax jurisdictions. And as a result, the effective tax rate, we are guesstimating - - estimating now, I don't wants to use the word guess, there is a precise calculation these guys worked on, it came in about 18% for the year. So you book that on year to date basis, and that's what we believe that will finish the year out, so that's what is in our guidance for fourth quarter.

(indiscernible) the shifting mix (indiscernible) --

Correct, because next we are looking at a substance amount of revenues in North America, tied to the Audiovox acquisition, and as we've talked about our international revenues, Japan, Latin America, southeast Asia, Europe, et cetera, will all be at higher tax jurisdictions.

Okay. Great, thank you.

Next question is from Daryl Armstrong of Smith Barney.

Thank you very much. The first question, you may mentioned that, I apologize if I missed it. Did you say in terms of your guidance for Audiovox what percentage of the handsets you're - - you're assuming that you are going to actually design and manufacture as opposed to the existing portfolio of handsets from Audiovox? And then the second question, you talked about a number of the competitors within the Chinese PAS handset market falling from a market share perspective and potentially exiting the market. How do inventories look within that market as these guys start to shrink? Have they been able to largely clean that out or is there still a little bit of overhang there? Thanks.

Alright, Daryl, out of $900 million that we've projected from Audiovox that we are hoping UTStarcom will be able to contribute about 200 -300 million dollars of the revenues from UTStarcom's handset. So we'll hope in the latter part of Q1or Q2 we will be able to start shipping some of our products to them. And the added value from non-Audiovox's is that we are also looking at the very high demand in some of our infrastructure building that we are building, including a 450's throughout the rest of the world, including the southeast Asia and also India. That's also going to give us an added benefit of our CDMA handsets that designed by ourself. Now, about China handsets portion, Mike?

I think you were asking specifically, you know, we could give you market share by the top people?

It was more in terms of the fact that some of the second and third tier suppliers fall by the wayside within the handset market, and start to receive from the marketplace. I'm sure that in the existing inventory in terms of PAS handsets that they have, that they probably want to flesh those through and get rid of them. My question is: if you sort of looked at the inventory levels of competitors in PAS handsets, what do they look like right now?

I really don't know about the other companies positioning. But we see very, very little percentage because majority of companies, 23 out of 32 companies, has a less than 1%, so they have a very insignificant movement. I don't believe that they have a lot of inventory because if they do, they will probably try to flush it out by now. Now, as far as UTStarcom's, I can tell you we have a less than one months of inventory in distribution, as well as to customer - - I mean, or the directly in the operator site. So combined with our operators inventory, as well as our distributors inventory combined, it's less than one months of inventory.

Next question is from (indiscernible) from Oppenheimer.

Hi. Can you hear me?

Yes.

Thanks. Most of my questions were answered, thanks for providing a lot of details on the call. That was helpful.

One thing I would like to follow up on is, as far as the time frame for the new handset designs with the new chip sets, you mentioned thats a Q1 target. I was wondering if you could just speak to what, in terms of the readiness there, what you'll actually have to do when get the, you know, the working samples late this year, between that point and having these things actually ready to ship. What would be the hurdles sort of beyond that?

Well, there are the - - since this is a very first chip, there's a - - we are anticipating a lot of unforeseen things. And this is adding a lot of new additional features, in other words, this one will have DSP versus the normal traditional Asyx, so it's a very programmables, and on top of that we have increased the coverage by 100%. In other words, compared to the old chip sets, it will have increased sensitivities and therefore it will result to higher, the wider coverage areas. And that means if we have the same situation put together, some of the handsets will no longer be able to, they will drop the cal,l and ours will be continue to be able to continue to talk. And therefore, that's not only saving on the chip set saving, but improving in our capabilities and the functionality or the improvement as well. So this is, we will be having our sample ready most likely by the end of this year, as we speak, but in order to make sure that interpretability(ph) with our systems and everything else is because this is the first time we're taking a little longer time. But with every single - - the indication tells us that the thing is working out very well.

Okay. So it sounds like when you get the working sample back, all this testing is basically been - - been accomplished successfully? Or --

Well, very basic one, we have accomplished successfully. Now, we will have to really bring it to the field to make sure that we are test out with the bay stations that we have, and also, that we don't know what we will encounter while we are doing the real tests that may coming up with some unknown portion that - - it's just the first time introduction always take a little longer than we want it to, and after that, we'll be able to increase speed much faster.

Okay, that helps a lot. One more thing if I might. I don't know if I'm thinking about this correctly, but if you are forecasting 900 million in revenue contribution from Audiovox in '05, and 200 to 300 million of that coming from UTStarcom's handsets, I think you mentioned that there was a 1 billion revenue run rate for Audiovox, so maybe kind of x-UTStarcom the amount of actual revenue contribution from Audiovox that you expect next year is a little bit more conservative than it's run rate you mentioned? Am I thing about that correctly?

Exactly - we were trying to - -that was part of what we exactly we were trying to accomplish on the call today is show that we were being conservative with our guidance, and there is hopefully a lot of upside to those numbers.

Okay. Thanks again.

Final question, is from Joe Noel of Pacific Growth Equities.

Thanks for giving me the last question here. Concerning Japan Telecom, the $290 million, can you tell us approximately how much of that order has shipped, and talk a little bit about when the cash will be received against that order?

Well, let me tell you about cash portion. We have already received the - - half of the payments. And from, we also have the service portion, so self service and equipment portion that we have to received the half. And as far as the shipment of against 290- - We expect it to ship out entire 290 cost a little bit extra. And in Q4, and we haven't shipped out everything yet, but we have shipped out entire, you know, chassis, and we are start shipping some of the boards, so I will probably say maybe about 50% of total shipment has been out, and we have 2 more months to do the rest of it.

So you received about 150 million in cash?

Against the equipment and then there's also a service portion.

Did that fall in Q3 or is that in Q4?

The 50% payment was in Q3, and we - - the way it works is once we complete the shipment of the equipment, roughly 30 days later, we get the balance of the payment.

Great. Okay, that's all I had. Thank you.

Linda, I got a note, could we just take one last question and then we need to wrap it up?

Yes, sir. The final question is from Noel Scotland at Lehman Brothers.

Hello?

Ms. Scotland, your line is open. They are not responding from that line, sir.

Okay. Then I think we thank you very much for joining our conference today, and we're happy to answer more further questions if you have any. Thank you very much.

This concludes todays UTStarcom third quarter earnings results conference call. You may now disconnect.